Death knell for Mt. Gox: Erosion of faith

As the Bitcoin exchange Mt. Gox was careening toward collapse in early February, its owner, Mark Karpeles, found that even some of his fellow virtual currency advocates were losing faith.

Members of the Bitcoin Foundation's board, an important promoter of virtual currencies, were losing confidence because the exchange had been associated with another foundation member who was arrested in January on money-laundering charges. The young currency in recent months had been increasingly backed by prominent investors, but the taint of any criminal activity was starting to take over the headlines.

Some wanted Mr. Karpeles, chief executive of Mt. Gox, the Tokyo-based site that once had been the favored place to buy Bitcoins, to either resign from the foundation or be removed from its board, said people briefed on the matter.

It was that steady erosion of faith in the Bitcoin community that ultimately served as the death knell for Mt. Gox, which had been enduring a series of problems, including having accounts frozen by authorities in the United States last year. Without the public backing of Bitcoin believers, Mt. Gox lacked the ability to get the financing it needed, those with knowledge of the discussions say.

On Friday, Mt. Gox filed for bankruptcy protection, five days after Mr. Karpeles resigned from the foundation and just days after its website suddenly went dark. The exchange said that most likely it had lost 750,000 of its customers' Bitcoin holdings and more than 100,000 of its own coins, or more than $450 million worth. youtube dealdash video

At a news conference in Tokyo, Mr. Karpeles, dressed in a suit instead of his usual T-shirt, bowed in contrition and apologized in Japanese.

''There were weaknesses in the system,'' he said. ''I'm truly sorry to have caused inconvenience.''

It is not clear how much lasting damage the collapse of Mt. Gox will do to the push by venture capitalists and wealthy investors to turn Bitcoin and other digital currencies into a viable alternative to traditional currencies like the United States dollar and the euro. Digital currency advocates say other exchanges were quickly supplanting Mt. Gox as the place for people to convert traditional currencies into Bitcoin, and the impact will be short-lived.

But American prosecutors are stepping up their inquiries. Prosecutors in the United States have issued subpoenas to several other digital currency companies, including Mt. Gox and the Internet Credit Union, based in New Brunswick, N.J., and one in Japan, said several other people briefed on the matter.

Prosecutors hope to better understand how money is transferred in the digital realm and converted from dollars to Bitcoin. The people briefed on the matter said they would not be surprised if authorities subpoena other companies and institutions involved in money transfers.

Many of Mt. Gox's woes came shortly after Charlie Shrem, another pioneer in the world of virtual currencies, was arrested by American authorities in New York on money-laundering charges on Jan. 26. He has also since resigned.

Mr. Shrem's arrest set off alarm bells at the foundation not only because he was a board member, but because the criminal complaint against him said his co-conspirator had used a ''third-party Bitcoin exchange service based in Japan'' to park his money. The clear reference to Mt. Gox unnerved the Bitcoin Foundation's other members, even though prosecutors did not claim any wrongdoing by either Mt. Gox or Mr. Karpeles.

For the foundation, which is dedicated to promoting the legitimate uses of Bitcoin and combating its popular image as a plaything for the rich or as a vehicle for online drug dealers to launder money, it potentially was too much of a public relations hit for both Mr. Shrem and Mr. Karpeles to remain on the board.

The case against Mr. Shrem, the 24-year-old chief executive of BitInstant, another Bitcoin exchange business, appears to grow out of the investigation into the now-defunct Silk Road, a virtual one-stop market for illegal drugs. His co-defendant, Robert Faiella, used Mr. Shrem's company to sell Bitcoin to Silk Road customers, some of whom used the electronic money to buy illegal drugs. Authorities said Mr. Shrem's company funneled more than a million dollars in Bitcoin to an account Mr. Faiella had at Mt. Gox to further the scheme, according to the complaint and people briefed on the matter.

The office of Preet Bharara, the United States attorney in Manhattan, has been particularly active in cracking down on the illegal use of digital currencies, which exist in an unregulated marketplace. Last year his office indicted the operators of Liberty Reserve, a firm that used its own digital currency to facilitate money laundering for online criminals, and the operators of the Silk Road.

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James Margolin, a spokesman for Mr. Bharara, declined to comment on the prosecutor's Bitcoin crackdown. Marc Agnifilo, a lawyer for Mr. Shrem, said his client intended to plead not guilty to the charges.

Mr. Shrem, who lives in New York and is also a part owner of Manhattan bar that allows patrons to pay in Bitcoin, remains one of the more vocal proponents of digital currencies even after his arrest. In conversations conducted on the phone and over email he defended Mr. Karpeles, whom he called a friend, and said any suggestion that Mr. Karpeles did anything wrong is ''preposterous.'' He said it was unfortunate that the foundation's other board members began to single out Mr. Karpeles.

''Mark had relayed to me that he's kind of frustrated with the Bitcoin community,'' said Mr. Shrem. ''He's frustrated with this whole thing.''

Over the last few weeks, Mr. Karpeles had been seeking additional financing. Last Saturday, Mr. Karpeles and a few of his close associates met to discuss a strategy to keep Mt. Gox operating. They put together a proposal and approached a small number of potential white knights, including Barry Silbert, chief executive of SecondMarket, and the Winklevoss twins, a person briefed on the discussions said.

But before those talks could progress, the proposal was leaked on the Internet and rumors of Mt. Gox's troubles scuttled any potential rescue.

''They were trying to come up with a solution,'' said Roger Ver, a 35-year-old technology entrepreneur who was present at one of the meetings. Mr. Ver has been working closely with the company and said he had up to 24,000 coins in the exchange when it went offline.

Mt. Gox then began warning other major Bitcoin exchanges that it was in trouble, and that its trading would soon stop temporarily, the person said. Once Mt. Gox went dark, it never opened for business again.

Bitcoin prices had briefly tumbled after the site went dark, but have since recovered. On Friday Bitcoin was trading at $539, according to the website Coindesk.

Still, Bitcoin investors are left to figure out what, if any, recourse they have against their losses at Mt. Gox. At least one class-action lawsuit has already been filed.

''I don't think people are going to get their money back,'' Mr. Ver said.

Mr. Karpeles, known in the close-knit Bitcoin sector as reclusive, purchased Mt. Gox from its founder, Jed McCabe, in 2011. Within two years, Mr. Karpeles helped transform it into an exchange that at one point handled 80 percent of all Bitcoin transactions.

But Mt. Gox's recent problems may have been taking a toll on Mr. Karpeles, who never seemed quite suited for the spotlight.

It was Gonzague Gay-Bouchery, described as Mr. Karpeles' right-hand man, who would represent him in meetings with the Bitcoin Foundation, according to people familiar with the meetings.

Even before problems surfaced at Mt. Gox, Mr. Karpeles rarely socialized with colleagues and worked constantly both at home and at work, according to one business associate who did not want to be identified for fear of compromising his relationship with Mr. Karpeles.

Tang Shunping, who runs an import-export business in Tokyo, said that he was trying to retrieve about 100 coins from Mt. Gox. Mr. Tang may have been among the last people to buy Bitcoin from Mt. Gox before it shut down, placing an order for 300,000 yen's worth of coins on Tuesday morning, according to his online bank statement.

Less than an hour later, the site went blank.

''I trusted Mt. Gox because it's the biggest name out there, and because it's based in Tokyo,'' said Mr. Tang.